An international panel of derivative clearing experts said more transparency is needed in crypto exchange FTX’s proposed direct clearing model but agreed it could open the door to an “evolution” of the current post-trade market structure.
The comments made on a panel at FIA’s IDX conference on 7 June came after market players expressed concerns over a proposal put forward by FTX in the US, which would allow customers to bypass futures commission merchants and become direct members of its clearinghouse. Although FTX has said that its initial focus will be on cryptocurrency futures and options, some in the industry believe that its model could be extended to other asset classes in the future.
The proposal includes an auto-liquidation mechanism that would enable FTX to automatically close out client positions if margin falls below predetermined threshold levels. The mechanism would operate 24/7, leaving market participants open to the possibility of being closed out overnight. Auto-liquidation is a common feature in platforms that provide retail traders access to foreign exchange markets, but in futures markets, FCMs give their clients several hours or longer to meet margin calls.
“Auto-liquidation, or any type of liquidation, comes with significant responsibility, and there needs to be a certain amount of judgment that's used in exercising that. While auto-liquidation is compelling when we think of risk and volatility in the system, it is not the right answer in all instances and circumstances,” said Alicia Crighton, co-head of global futures at Goldman Sachs.
“It's an interesting proposal. It has created a lot of energy, which is important, but there is still a lot more transparency that we need about the model.”
Gary Saunders, global head of prime derivatives services at Barclays, said the idea of applying the same principles used for retail investors to institutional investors would be difficult in the current framework.
“I can see how the model works with retail clients with the natural size of their positions, but if you go and apply that to an institutional client base, it is highly unlikely that an asset manager would want to be blown out of their position or lose their hedge at 2am on a Sunday because they didn't meet their margin call,” he said.
“Maybe that’s because in today’s world cash moves around the system Monday to Friday and not on weekends. There are certain things that need to catch up in order for that to be a reality.”
However, despite their concerns, the panelists agreed that reform of the current clearing structure was feasible and that while the FTX proposal might not be workable in its current form, it offers some interesting possibilities.
“I think [the FTX proposal] will help us to evolve the model. The model should evolve, but I do think where we probably end up is in some sort of a hybrid structure,” said Crighton,
“We have to be cautious about how we do it, but I do think there is space for a hybrid model. I don't think it fits all our markets, particularly not what's being proposed at the moment, but it's an interesting discussion point,” said Crighton.
Saunders added that clearing infrastructure has worked well through the recent high volatility and volumes but there is room for careful improvements.
“Are there things in the proposal that we should look at and try and adopt? Yes. But we've got to be careful that we don't throw away what we've got now and implement something new, especially if it's not tried and tested. I think people generally prefer evolution to revolution.”
Another point of concern for the panelists was the proposal's direct clearing approach, which would take intermediaries out of the customer trading and clearing process. In the US, several companies have received regulatory approval for this model, but only with respect to fully collateralized contracts. FTX is seeking to extend this model to margined futures, which potentially could open the door to much more widespread usage.
Maylis Dubarry, global co-head of prime services at Société Générale, questioned this approach, saying it was not clear how the FTX model would help meet all the needs of the bank’s clients.
“We face clients, we face CCPs, but altogether we do so much more for clients -- from our capacity to analyze the credit risk of all our clients to accompanying our clients day to day with their level of risk, proposing potential margin financing, cross-margining and optimization… all those kinds of things that these kinds of companies cannot offer.”
Robbert Booij, chief executive officer for Europe at ABN Amro Clearing, agreed, saying, “We do all the things that really nobody wants to do. It's about anti-money laundering and financial client checks. It's about sanction screening and about really thorough customer due diligence, knowing the ins and outs of who your clients are. This intrinsic knowledge of the client is something that we should not take for granted..”
- Market Structure